The plight of the hedge funds and the mortgage backed securities is interesting, but SO is more concerned about the economic situation going forward. While some / most of the collateralised debt obligations (CDOs) are toxic waste, the real problem lies when new credit is difficult, if not impossible, to get.
From the Economicst
With some $100 billion of adjustable-rate subprime mortgages due to reset to higher rates by October, investors are likely to remain twitchy. Moreover, lenders have tightened underwriting standards across the board for both prime and subprime mortgages, making it harder for borrowers to refinance loans.
What a concept – real “good credit” that can be documented, actual down payments of 20% from savings, prices that haven’t been inflated by appraisers and flippers. Is there anyone like that left? Would they even want to buy a previously owned McMansion?
That is probably only the start. Home ownership isn’t even usual in most of the developed world, so it this all goes away, it wouldn’t be the end of civilization as we know it. Quite the contrary.
However, corporate borrowing is a huge concern going forward.
But perhaps the most worrying thing for financial institutions holding mortgage-backed paper is not the subprime market itself, but the unnerving parallels with an even bigger one to which they are also exposed: leveraged loans to companies. As Daniel Arbess of Xerion Capital Partners points out, corporate lending’s giddy leverage echoes the high loan-to-value ratios in subprime; the explosion of â€œcovenant-liteâ€ deals and payment-in-kind notes mirrors that of interest-only and negative-amortisation mortgages; and leveraged buy-outs have their own form of mortgage refinancing in the so-called dividend recapitalisation. Subprime, says Mr Arbess, might well be â€œa dress rehearsal for something bigger and scarier.â€
All this talk about stock repurchasing and corporate profits ignores the fact that much of the corporate debt is unlikely to be sustainable. Then it will be very difficult for the next generation of entrepreneurs to get financing for the innovation and real economic growth that the US so badly needs to be competitive in a global market.